Wells Fargo: Too Early to Abandon High-Yield Market

By Michael Aneiro

Junk bonds just can’t keep investors away these days, The high-yield market keeps setting record-low yields and record-high dollar prices, and recent high-yield bond offerings have been getting riskier, but investors keep on feeding money into junk bonds. Even if it’s being enabled by the Fed, this seemingly improbable confluence of forces has investors keeping a wary eye on the market.

Not to worry, says Jim Kochan of Wells Fargo Advantage Funds, at least for a while. He points out that risk premiums over Treasuries are still above their historic averages, and the default rate remains below its historic average, and is expected to stay there. Beyond that, investors need to be mindful of the unusual nature of the current interest-rate cycle, which still augurs well for the high-yield market, and that recessions are greater threats to high yield than periods of rising interest rates. From Kochan:

It is natural to become wary of a market that has rallied as much as high yield over the past three years. While it might be prudent to underweight the most risky sectors of the market after such a strong rally, it is probably too early to abandon the high-yield market entirely. A focus on shorter-maturity portfolios with limited exposure to the weakest credits would be a better risk-reduction strategy than to abandon the high-yield market. Key fundamentals such as yield spreads to Treasuries, default rates, and the outlook for the economy are suggesting that this market can continue to be the best-performing segment of the domestic bond market over the next 12 to 18 months. Total returns will probably not match those of the past three years, but they should continue to be substantially greater than returns from such “safe” sectors as cash equivalents and Treasuries.

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There are 2 comments

OCTOBER 22, 2012 12:46 P.M.

Thomas wrote:

Well, Jim Kochan of Wells Fargo, why don't you put all your savings into junk bonds then, if you think they are still so good?

What a crook.

OCTOBER 22, 2012 7:59 P.M.

Wealth Effect Blogger wrote:

I agree that high yield bonds should remain part of a balanced income portfolio but I disagree that the default rate is expected to stay low and the sweet spot is short term maturities. If you only focus on the difference in yield between short term high yield bonds 1-3 years to maturity that pay 1-2% and treasuries that pay 0-1%, then yes high yield bonds yield more, however, the yield you are receiving may not be worth the risk of purchasing these bonds. I would much rather hold long term high yield bonds (approx 10 yrs to maturity) that pay 6-8% vs treasuries that pay 1-2%. Also high yield companies must pay down or refiance their short term bonds so there is a cash crunch looming for these companies vs. long term high yield bonds where the company must only come up with the interest payment in the near future. http://www.yourwealtheffect.com

Amey Stone is Barron’s Income Investing blogger and Current Yield columnist. She was formerly a managing editor at CBS MoneyWatch, MSN Money and AOL DailyFinance. Her responsibilities included overseeing market coverage and personal finance topics. Prior to those roles, she was a senior writer at BusinessWeek where she authored the Street Wise column online and contributed to the magazine’s Inside Wall Street column. Topics covered included economics, corporate finance, Fed policy, municipal bonds, mutual funds and dividend investing. She co-authored King of Capital, a biography of Citigroup Chairman Sandy Weill. She is a graduate of Yale University and Columbia University’s Graduate School of Journalism.